How to Calculate the Return on Equity With Retained Losses
Original post by Bryan Keythman of Demand Media
If a company shows retained losses, or an accumulated deficit, in the stockholders’ equity section of its balance sheet, it has generated more losses than profits since its inception. This is in contrast to retained earnings, which means a company has generated more profits than losses. An accumulated deficit reduces stockholders’ equity. If the company’s accumulated deficit is less than its paid-in capital from stockholders -- resulting in stockholders’ equity that is still positive -- you can calculate its return on equity. ROE measures the amount of profit a company generates for every dollar of stockholders’ equity.
Find a public company’s balance sheet and income statement in its 10-K annual report. You can obtain this report from the investor relations section of its website or from the U.S. Securities and Exchange Commission’s online EDGAR database.
Identify the amount of the company’s net income, listed on its income statement. In this example, assume the company has $500,000 in net income.
Determine the amount of the company’s total paid-in capital and the amount of its retained losses, or accumulated deficit, listed in the Stockholders’ Equity section of its balance sheet. A balance sheet shows an accumulated deficit amount enclosed in parentheses to designate that it reduces stockholders’ equity. In this example, assume the company’s balance sheet shows $2 million in total paid-in capital and $400,000 in an accumulated deficit.
Subtract the accumulated deficit from total paid-in capital to calculate total stockholders’ equity. In this example, subtract $400,000 from $2 million to get $1.6 million in total stockholders’ equity.
Divide net income by total stockholders’ equity to calculate the company’s ROE. A higher ROE is better. In this example, divide $500,000 by $1.6 million to get 0.31, or a 31 percent ROE. This means the company generates net income equal to 31 percent of its stockholders’ equity.
Tips & Warnings
- Compare a company’s ROE with those of its competitors to determine what level of performance it should be achieving.
- AccountingCoach; Paid-in Capital and Retained Earnings; Harold Averkamp
- NetMBA.com: Financial Ratios
- AccountingTools; What Are Negative Retained Earnings?; Steven Bragg; December 2010
About the Author
Bryan Keythman has performed stock investment research and writing for a consulting firm since 2008. He also has prior experience sourcing and underwriting commercial real-estate investment and development opportunities for a commercial real-estate developer. Keythman holds a Bachelor of Science in finance.